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Depth to make a difference in times of uncertainty

25 March 2020
Jeremy Wilmot, Head of Advisory Consulting

With all the current uncertainty, Jeremy Wilmot discusses the unfolding investment impacts of coronavirus and what approaches investors should be taking amidst the turmoil.

Our world and its markets are being rocked by the COVID-19 health crisis and the unprecedented speed of its global contagion. The world of investing is always challenging, but never more so than when you are in the midst of a major market sell-off. While governments and central banks can deal with normal economic cycles, no one has experience dealing with the impact of a global pandemic of this scale.

Lowering the mortality rate is rightly the key focus. However, from an economic standpoint, this has a negative side effect of prolonging the period of economic "lockdown". It is the economic impact that has driven the nearly 30% falls in global stocks, with the economic and earnings outlook unclear at best.

Despite the uncertainty, there are some basic approaches to help investors survive this crisis, and position themselves for inevitable recovery. Firstly, don’t panic; selling stock now will simply lock in losses. Consider retaining capital for re-investment as a rebound approaches and finally, embrace diversity in investments as a buffer against future shocks.

While at JANA we did not predict the unfolding pandemic, we had the view that markets were pricing in a lot of positive news (i.e. they were expensively valued) prior to this emergence of COVID-19. Risk in capital markets is unavoidable and as an investor you have to accept it, but you also should be appropriately compensated for taking it. This is why it is a much riskier proposition to buy assets when valuations are high, because if something goes wrong, prices have much further to fall. In part, this explains the rapid falls we have seen in equity markets over the past three weeks, which have been on par with the severity investors saw during the 1987 crash.

So what does this mean going forward? As we sit in the midst of the unfolding COVID-19 crisis, we need to step back from the human and social impact and take a longer-term view on markets. As investors looking after the welfare of beneficiaries, we need to have a view. We have been through many economic and market cycles over the past 100 years, but what we are seeing unfold at the moment is unprecedented in this period, with the Spanish Influenza pandemic of 1918-20 being the last widespread global pandemic.

The challenge from an investment perspective arises around estimating the length of time the economy is in "lockdown" as this will have a direct impact on how far corporate earnings fall. But as with every other crisis markets have faced in the past 100 years, there will be a rebound. People will eventually go back to work and companies will once again start growing their earnings. The current sell-off will present an opportunity for long-term investors to buy assets at what will likely be viewed as low prices in the future.

Just as greed can lead to markets rising well above fair value, the inverse is true for fear and at times like this, as an investor, it is essential to not panic. Markets have already seen significant falls and, while they could fall further, selling equities at the moment would be locking-in permanent capital losses. Eventually, markets will recover; it is just a matter of timeframes. Selling now is likely to look like a silly decision in 10 years' time. Instead, the focus should be on ensuring investors have enough cash available to take advantage of opportunities which will inevitably arise. No one knows where markets will bottom out, but we are definitely a lot closer to the bottom than we were three weeks ago.

It also reminds investors of the benefit of diversification. With equity markets down heavily, other asset classes have been less impacted. Bonds have continued to provide a hedge, while foreign currency exposure has been beneficial as the Australian dollar has come under selling pressure. Portfolio volatility has also been dampened for those investors who have exposure to unlisted property, infrastructure and private equity. While these assets will undoubtedly see negative impacts in the future, the lack of volatility during times of crisis is valuable from both a return perspective, but also from giving comfort to beneficiaries.

The economy will likely be depressed for months to come, but the world will go on (although maybe not as we have previously known it). What is clear is that in the long run, economies, financial markets and, most importantly, the human spirit will recover.

Jeremy Wilmot, Head of Advisory Consulting